Doral Plans Big Restatement

Misaccounting for hedging derivatives could cut $600 million from prior-period earnings.
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Puerto Rico-based mortgage lender

Doral Financial

(DRL)

, which has seen its stock crushed this year on concerns about its use of derivatives, said Tuesday that it plans to restate earnings for the past four years.

The bank said it might restate earnings by as much as $600 million because of continuing problems with its use of interest rate-only strips, a special type of security, to hedge its mortgage portfolio.

Shares of Doral were down $1.11, or 6%, to $15.81 following the announcement.

Doral, in a press release, said it decided a restatement was necessary after "consulting with various financial institutions'' about the proper valuation for the so-called floating rate IO strips.

The bank said the restatement, on an after-tax basis, could reduce past earnings by anywhere from $290 million to $435 million. Doral said it may have overvalued its portfolio of IO strips by as much as $600 million.

Last year Doral earned $809 million.

The restatement will delay the release of Doral's first-quarter earnings. The bank also said the outside directors on its board had hired Latham & Watkins, a big U.S. law firm, to "review the facts and circumstances relations to the IO valuation issues.''

Problems with Doral's derivatives portfolio surfaced early this year, when the bank reported fourth-quarter earnings for 2004. At that time, Doral took a $97.5 million pretax impairment charge on the securities, which are used to hedge the value of its portfolio against fluctuations in interest rates and to record gains of the sales of some of those mortgages. Doral's management, in a January conference call, downplayed the impairment charge, denying the bank had suffered any problem with its hedging strategy.

But many on Wall Street didn't buy it and feared the bank was sitting on a potential derivatives mess.

Things only got worse for Doral in March when it released its 2004 annual report and disclosed that it may have been using overly aggressive assumptions in valuing its derivatives portfolio of interest-only strips. The series of disclosures led to a number of analyst downgrades and credit warnings from several ratings agencies.

As of the start of trading on Tuesday, shares of Doral had fallen 65% this year to a little under $17.

The selling in Doral shares marks a horrific turnaround for the stock, which had been one of the best-performing bank stocks during the low-interest rate fed-mortgage refinancing boom. The stock, which was trading around $49 a share at the beginning of the year, had risen 172% since the beginning of 2003.